Brexit – What Next?

What are the business implications of Brexit?

After the shock and confusion which greeted the result of the referendum on 24 June, some limited clarity is beginning to emerge about the implications and the possible shape of the UK’s relationship with the European Union and its other 27 member states after the vote. It seems that we are in for a very long haul to sort out the fine detail over many years, a task which will consume huge amounts civil service resources, public spending and Parliamentary time (both nationally and in the devolved administrations) probably for the next five years. The implications will be far and wide for business, public services and the not for profit sector.

Pushing the start button on Brexit

Article 50 (2) of the Lisbon Treaty states:

‘In the light of the guidelines provided by the European Council, the Union shall negotiate and conclude an agreement with that State, setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union. It shall be concluded on behalf of the Union by the Council, acting by a qualified majority, after obtaining the consent of the European Parliament.’

Nothing changes formally until the UK gives a notice under Article 50 of the Lisbon Treaty that it wishes to leave the European Union. Once that notice is served, there is a two year period to negotiate the terms of the UK’s exit. The exit agreement has to be approved (a) by a majority in the European Parliament (which interestingly will include our own MEPs – 73 out of 751 in total) and (b) by at least 15 out of the other 27 member states, representing at least 65% of the EU’s population. If no agreement is reached by the end of the two year period, then we simply leave with no transitional arrangements in place and EU laws, rights and obligations would cease to apply to the UK from that date (unless our Parliament opted to keep them alive) and no trade agreement with EU countries for the future. If that happened, the UK and EU would begin to impose tariffs on each others’ imports, increasing the price of goods and services. 48% of our exports go to EU countries and 54% of our imports come from there. The rights of millions of individuals and businesses would remain unresolved. The two year period can only be extended if all 27 member states agree to extend it.

It is self-evident that obtaining the agreement of at least 15 out of 27 nations and the EU Parliament to the terms of the exit agreement in such a short space of time will be a tall order. There is likely to be ‘horse trading’ between nations over issues which concern them most: for example, Denmark and Spain may be particularly concerned to block a wider deal unless they get what they want on fisheries policy, Germany may be particularly concerned with car exports and so on. MEPs are also likely to be very concerned to protect the rights of EU citizens living and working in the UK. Time will not be on the UK’s side and our negotiating position may not be particularly strong. Any politically motivated precipitous action to limit immigration by the UK could provoke retaliation and delay by the other countries, descending quickly into market disruption.

One critical area to get right will be the issue of acquired rights. An estimated 2 million UK citizens live and work in other EU countries, while around 3 million EU citizens live and work in the UK. Detailed arrangements will be necessary to cover rights acquired prior to the UK’s withdrawal. The arrangements would need to cover residence rights, rights to take up employment or self-employment, and rights to health care and social security. There will need to be agreement on the dates from which acquired rights would be recognised (the date of the referendum?), and transitional arrangements for those not qualifying for acquired rights.

Large areas of social and economic policy are underpinned by EU legislation. It would cause great legal and commercial uncertainty if all these laws simply disappeared overnight (take for example public procurement, Working Time and TUPE regulations, health and safety, environmental regulations, consumer protection, cross border divorce settlements and child custody arrangements, and intellectual property laws). Therefore, it is likely that most of them would have to be preserved in UK domestic law by ministers making orders under sweeping delegated powers to keep them in force until such time as a massive sifting and review process can take place over the coming years. Ministers are likely to have very extensive powers during this period which may not be fully amenable to Parliamentary scrutiny.

It is worth noting also that the agreement to limit ‘in work’ benefits to a 4 year qualifying period and capping child benefits negotiated with the EU in February has now fallen away as result of the referendum result, so in the short term we may actually see an increase in immigration and benefit payments. Under a previous deal newly arrived EU migrants are banned from claiming jobseeker’s allowance for three months. If they have not found a job within six months they can be required to leave. EU migrant workers in the UK who lose their job, through no fault of their own, are entitled to the same benefits as UK citizens, including jobseekers’ allowance and housing benefit, for six months.

It has been suggested that the terms of a new trade agreement could be negotiated in parallel with the exit agreement. Article 50(2) uses the words ‘taking account of the framework for its future relationship with the Union’ which would appear to lend some weight to this. However, the EU’s trade commissioner Cecilia Malmstrom stated on 30 June that negotiations on a new trade agreement cannot begin until the exit agreement is complete

Leaving aside the question of who can start the process of withdrawal, it seems inevitable that a Parliamentary vote will be required on at least 3 things: (i) the repeal of the European Communities Act 1972 (the legislation which brought EU law into our domestic legal system and makes it enforceable in UK courts) (ii) the approval of the terms of the exit agreement and any transitional arrangements for UK citizens’ and businesses’ rights and obligations pending a new trade agreement (iii) approval of the terms of a new trade agreement.

What could the new relationship with the EU look like?

This is a complex multi-layered question which has political, economic and legal dimensions. On the political level, Brexiteers based their campaign on four key principles: (i) regaining sovereignty for the UK Parliament (i.e. British MPs should have the power to decide on laws and regulations and not be forced to comply with EU laws) (ii) free movement of migrant workers into the UK should be limited and (iii) the UK should cease making large financial contributions into EU coffers, so those funds could be redeployed for domestic priorities like the NHS (iv) the UK should be free to strike new free trade deals on a bilateral basis with other nations. In considering the possible scenarios which follow, it will be important to keep a keen eye on whether these objectives have actually been met – if not, one might ask why have we put ourselves through all this upheaval?

A unit was set up in the Cabinet Office under the leadership of the outgoing minister Oliver Letwin MP to consider all the options; this now forms part of David Davis’s Minister for Brexit portfolio. The unit currently has 43 employees plus a small number from the FCO and DFID who deal with trade policy. Trade negotiators will need to be hired in, we are told.

What models are being considered?

Economics tells us that we can benefit when goods and services are traded. Simply put, the principle of “comparative advantage” says that countries prosper first by taking advantage of their assets in order to concentrate on what they can produce best, and then by trading these products for products that other countries produce best. In other words, liberal trade policies — policies that allow the unrestricted flow of goods and services — sharpen competition, motivate innovation and breed success. They multiply the rewards that result from producing the best products, with the best design, at the best price.

However, the temptation to ward off the challenge of competitive imports is always present. Richer governments are more likely to yield to the siren call of protectionism, for short term political gain, through subsidies, complicated red tape, and hiding behind policy objectives such as environmental or consumer protection as an excuse to protect domestic producers. This is what the single market within the European Union was designed to eliminate – and it has done so quite successfully. Key areas of our economy which will be affected by the terms of any future deal are pharmaceuticals and specialist manufacturing industries, financial services, farmers and universities. It is worth keeping in mind that services make up 78% of our GDP, and around 10% of that is financial services (which account for 25% of our service exports). Worth bearing in mind also that financial services businesses account for around 12% of tax receipts which can be used to pay for public services (leaving aside the personal tax revenue generated from high earners in the City).

The new models on the table so far:

The ‘Norwegian’ model – European Economic Area (EEA) membership

This would involve remaining a member of European Economic Area. While this model scores highly in terms of maintaining market access, it falls short in terms of guaranteeing the UK a say over the rules (Norway has no veto at the European Council, no votes in the Council of Ministers and no representation in the European Parliament). It also does little for independence and sovereignty, given that most EU policy areas would continue to apply post Brexit. Crucially, this includes the free movement of people. However, the UK would gain the ability to negotiate its own trade deals with individual non-EU states (access to individual EU member states markets which account for 48% of our exports would still depend on reaching an agreement with the EU bloc as whole, since individual countries can’t do their own deals). This would also remove the UK from the Common Agricultural Policy (CAP), Common Fisheries Policy (CFP), EU-wide regional policy, and reduce its budget contribution. However, while guaranteeing access to the single market in services and goods, outside the customs union, access for our goods would be subject to complex rules of origin and Britain would still be subject to EU regulations on employment and financial services but with no formal ability to shape or influence them.

The ‘Swiss’ model

This model provides a mixed level of market access – it is relatively comprehensive in terms of goods but falls short in terms of access for services we sell, particularly for financial services (our exports of services to EU countries account for 40% of the total, and around a quarter of that is financial services). This model would give little say over the rules: Switzerland essentially has to mirror EU legislation in key areas where it wants to secure single market access. It does score more highly than the Norway/ EEA option in terms of gains in independence and sovereignty: several policy areas including social and employment law would return to the remit of the UK government. However, it still involves keeping free movement of people. The Swiss-EU bilateral deal, without the Common Agricultural Policy, EU fishing rules, EU-wide regional policy, and reduced financial contribution, offers more sovereignty and less EU regulation.

The ‘Turkey+’ model

The UK would continue to benefit from full access to the EU’s single market in goods by remaining in the customs union with the EU but the UK would still be bound by any external deals that the EU strikes in trade in goods without any formal way of shaping them. Crucially, the deal completely excludes services, agriculture and public procurement. A separate deal on services would be essential to maintain UK access to the single market in these sectors. It would remove the UK from EU social and employment regulation, the CAP, CFP and EU-wide regional policy.

The Canadian Model

The EU’s trade agreement with Canada (CETA) is very ambitious and took over 5 years to conclude. This agreement gradually eliminates tariffs on all industrial and most agricultural tariffs. It smooths out regulatory barriers, but unfortunately financial services are excluded. Any agreement along these lines would have to go much deeper with the UK and the EU would probably demand grater oversight and regulation.

‘Full break’ – the WTO option

If the UK left the EU without securing a version of the options above, the UK could fall back on its membership of the World Trade Organisation. The WTO, based in Geneva has several international treaties covering trade in goods (GATT) and services (GATS). Its main function is to ensure that trade flows as smoothly, predictably and freely as possible.This would see some exports facing relatively high tariffs (e.g. 25% on car exports, 10% on car parts or 35% on dairy products) and market access for services would be very limited.

This model understandably scores low in terms of continued EU market access as it entails no preferential agreement covering the 50% of our trade which is with the EU. Some key goods exports would face high tariffs and accessing EU services markets would become much harder, particularly in financial services. Likewise it offers the UK no say over the rules, but may offers scope for gains in independence and would not involve complex negotiations with the EU.

The likelihood is that the UK would need to negotiate some form of bespoke arrangement. However, the fundamental trade-off is unavoidable: the fullest EU market access means accepting greater ‘obligations’ (be they on regulation, some form of contribution to the EU budget, or accepting the free movement of people)

Practical responses to current uncertainties

Businesses and organisations with exposure to European trade flows and EU regulations are the most likely to be affected by the changes. Consider the following areas for action in the short-term:

What do your supplier contracts say (if anything) about the risks associated with tariffs and non-tariff barriers and formalities- can you pass increased costs on to your supplier or customer or bail out completely if it becomes uneconomic?

What do your contracts say about the allocation of risks of changes in law or regulation- can you trigger any price adjustment mechanisms?

Consider the impact of any future restrictions on freedom of movement for any of your workforce from other EU countries – consider whether their position could be regularised e.g by applying for visas or permanent residence? What practical steps could you take to reassure them in the short term? Hospitality, healthcare, construction and recruitment sectors are likely to be particularly hit.

Do you rely on any EU grant funding programmes which could be affected by the changes?

Review supply chains to assess how they may be affected by the introudction of tariffs or loss of labour from EU countries.

Consider whether opening a presence in another EU member state may help preserve your access to the Single Market?

EU law continues to apply in full in the short term so be alert to any actions by competitors or suppliers which attempts to deviate from it, but equally ensure you respect the rules as well.

Now more than ever, keep an eye on your markets and be alert to changes, review your liquidity and cash flow and your cost base so you are nimble enough to cope with challenging economic conditions

Conclusions

Pre-referendum, most economists agreed that as a result of the decision to leave the EU we could expect to see in the short to medium term impacts on the economy:

Lower real wages

A lower value of the pound

Higher government borrowing, lower public spending or higher taxes

In the short term, higher unemployment

Without doubt leaving the EU means a degree of economic dislocation with the UK’s largest trade partner and therefore an economic cost, estimated to be a loss in the range of 0.5% to 1.5% of GDP over the medium-term, depending on the exact terms of the exit agreement with the EU. It may be possible for the UK to get back into positive growth over the long-term, but only if the UK takes a ultra-liberal approach to trade, immigration and deregulation. Free trade agreements inevitably involve opening up more domestic markets to greater competition from overseas (in particular the US and Asia) as a quid pro quo for access to their markets, and we may now see a new wave of immigration, this time increasing competition for skilled jobs. One thing that is clear is that Brexit cannot be all things to all people. As I said in an earlier post pre-referendum –it could be a case of ‘be careful what you wish for’. The costs and distraction of all this could detract significantly from other pressing national priorities- such as increasing investment in manufacturing capacity, improving infrastructure and finding solutions to the ticking time-bomb of health and social care costs. If the Brexit deal does not achieve the four key objectives set out above, it could be the greatest Pyrrhic victory ever. Without doubt, we are entering a very challenging period.

Mark Johnson is a solicitor, chartered company secretary and trusted advisor to SME’s, not for profits and public bodies. If you would like to discuss implications of Brexit, please get in touch at elderflowerlegal.co.uk.

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